A Look Beyond the Crisis - Perry Piazza Presentation Transcript
A Look Beyond the Crisis Perry Piazza Director of Investment Strategy Contango Capital Advisors, Inc. December 2, 2010
Part 1: Crisis Review, Deleveraging Update & Economic Forecast Part 2: Our Fiscal Mess – Is There Hope? Part 3: How to Invest in 2011 2
Setting the Scene A debt bubble began to form in the mid 1990s and continued into the last decade. It was exacerbated by: Abnormally low interest rates. A strong rally in the price of an easily leveragable asset – housing A fundamental switch, from cash-flow based underwriting standards to asset-based underwriting standards. Fast growth in computer power and the ensuing ability to securitize all manner of assets. A miscalculation of risk by the ratings agencies. Abdication of regulatory responsibility. The debt bubble began to burst in 2007 when housing prices cracked and finally gave way fully in 2008 when Lehman Brothers failed. 3
The Debt Bubble in Hundred-Year Perspective 4 Total Debt as a Percentage of GDP in the USA … and probably again in 2008 Includes Government + Household + Corporate Debt A large debt bubble burst in the 30s … Source: Ned Davis Research
What Happens After a Debt Bubble Bursts? Typical aftermath:
Deeper than normal recession and a muted recovery
Deleveraging by the biggest culprits (consumers, in this case)
Austerity & reduced confidence to spend and invest
A flirt with deflation
Untested policy responses & political “tide-shifting”
Large fiscal response
Asset market(s) most affected (e.g., housing) usually fall for years
A shifting of relative economic strength to less indebted countries.
A transfer of risk from the private sector to the public sector
Periodic “aftershock” crises.
Recommended Reading .
2007 – 2009 was the first severe credit recession since the 30s.
Deeper Than Normal Recession 6 Quarterly GDP Growth in the United States Source: Bloomberg, LP The amplitude of economic activity has moderated greatly in recent decades
Muted & Well-Below-Par Recovery 7 Performance of Coincident Indicators vs. Average of Last Six Expansions What’s Normal What’s Not Average increase in above economic variables, 34 Months after the start of a recession (includes last 8 recessions with the exception of the truncated 1980 recession) Current “Recovery” Source: Ned Davis Research
Consumer Deleveraging 8 Household Debt / Disposable Income Source: Ned Davis Research
Austerity Cumulative Net Worth in Trillions of All US Households To repair their net worth, individuals (representing 70% of our economy) save more and spend less. Confidence is eroded, leading to fewer purchases of “big ticket items (homes & cars, for example). 3 Decades of the U.S. Personal Savings Rate Individuals Feel Poorer So they save more ? Source: Bloomberg Compounding the problem, the baby boomers are now quickly approaching retirement. 9
10 Reduced Business Confidence + Structural Problems = Weak Hiring Performance of Private Nonfarm Payrolls Millions of Employed Americans Average of Last 6 Expansions Why?
Machines replacing people
Failures of education system
1991 “Jobless Recovery” 2001 “Jobless Recovery” Source: Ned Davis Research
Flirt with Deflation 11 Inflation (core personal consumption expenditure “PCE” y/y change) Fed’s Target Range 1995 thru 2007 Source: Ned Davis Research
Untested Policy Response 12
As a Result of Unconventional Monetary Policy, Fed’s Balance Sheet Has Increased Substantially 13 QE2 Begins Federal Reserve Balance Sheet Black Dotted Line = GSE (Fannie & Freddie) Debt Red Dotted Line = MBS Blue Line = Treasuries Green Line = Total Securities Held QE2 QE1 Begins End Treasury Buys End QE1 Securities Held by the Fed QE1 Expanded Source: Ned Davis Research
The Fed’s Actions Have Effectively Engineered Lower Rates 14 30-Year Fixed Mortgage Rate 2-Year New Car Loan Rate Sources: Haver Analytics and Gluskin Sheff & Associates
But Demand Hasn’t Significantly Picked Up for Housing 15 Mortgage Bankers Association: Mortgage Loan Application for Purchase (seasonally adjusted) Conference Board: Consumer Confidence Survey: Plan to Buy a Home Within Six Months Sources: Gluskin Sheff & Associates, Mortgage Bankers Association, Conference Board
And Prices Keep Falling 16 FHFA House Price Index Source: Ned Davis Research
We’ve Also Had a Big Fiscal Response I’m Back 17
With Spending Far Exceeding Tax Receipts 18
During massive stimulus programs (like the New Deal), outlays widely outstrip receipts.
‘Ammunition’ for the next battle becomes dangerously low.
Federal Receipts Federal Outlays Source: Ned Davis Research
And Federal Debt Rises 19 U.S. Government Debt as a Percentage of Our GDP (post war period) State and Local Government Debt GSE (Fannie & Freddie) Debt Treasury Bonds Outstanding Treasury Bonds Held by the Public American Recovery and Reinvestment Act of 2009 Source: Ned Davis Research
So We’re Getting Some Political Tide-Shifting 20
Economic Strength Is Shifting 21 BRICs - Brazil, Russia, India, China – (in billions of dollars) Sources: JP Morgan & Emerging Markets Management, Inc. Point: Emerging economies are growing and becoming more and more important
And Emerging Markets Have Outperformed 22 Performance of International Markets Since E/M Bottom Source: MSCI
E/M Strength Has Also Been Driving Up Commodity Prices 23 Source: Ned Davis Research
A Bright Spot Has Been Large U.S. Corporations 24 Source: Ned Davis Research S&P Sales Growth, Earnings Growth, & Profit Margins
Why Are Large U.S. Corporations Doing So Well? The “blue chips” are selling globally and have tapped into the best growth areas well. Have extracted huge productivity gains in recent years Labor outsourcing has helped improve margins; global supply chain reduces costs and improves quality. They’re benefiting from ultra-low borrowing costs right now. They have captured market share from small business and failed competitors. 25 Apple Store - Beijing McDonalds - Shanghai
Conclusions: Part 1 Consumer deleveraging is ongoing and will continue to crimp growth. The crisis has generated deflationary tendencies, which are being fought aggressively with monetary and fiscal stimulus. Government demand has partially substituted for private demand, but the recovery remains subpar by historical standards. With a super-high debt level, the government has few “bullets” left. In any case, the Tea Party crowd will probably fight any new stimulus. Active policy cycle means policy mistakes are a key risk:
Too easy too long = inflation and asset bubbles.
Not easy enough = deflation and a dragged out Japan-style purgatory
Too much fiscal response = possible Greek/Irish-style debt crisis
There are two bright spots: both blue chip corporations and most emerging market countries are posting very decent growth. 26
Part 2: The Fiscal Mess: Can We Overcome our Debt Burden?
Federal Debt to GDP at a New High 28 US Treasury Debt Relative to GDP (postwar period) Source: Ned Davis Research Is it possible to crawl out from under such a debt burden?
U.K. U.S. It Is Possible 29 US and U.K. Post War Debt Burdens (Debt to GDP) But …
Demographics were much more favorable in the ‘50s
16 workers per retiree in 1950
3 workers per retiree today
We were in our China-like growth phase.
Fewer built-up entitlements.
WW2 had destroyed the competitiveness of much of the rest of world.
The UK did a lot of the work with inflation.
Source: Niall Ferguson
High Debt Has Led to A Crisis in Europe 30 PIGS = PORTUGAL IRELAND GREECE SPAIN Yield Spread Over Treasuries Source: Bloomberg, LP
But It’s Not That Much Worse in the PIGS? 31 Government Debt to GDP (mid-2010) Source: IMF Harvard economist Niall Ferguson has coined the phrase the PIGS ‘R US.
Unlike Japan, We Don’t Buy Our Own Debt 32 Source: Fusion IQ
33 Source: Fusion IQ
We Can Do It if We … Change the tax system and expenditures to foster growth. Accept that you cannot have a universal provision of social benefits. Eliminate debt via some inflation. Encourage a rebalancing of the economy away from consumption and toward investment. 34
If We Don’t Get Smart 35 = We’re Doomed to This Outcome
Japan Has Been in a Slow-Motion Depression for 2 Decades 36 Source: Gluskin Sheff & Associates
How to Invest in 2011 In a slow-growth low-yield world, growth and income should carry a premium. Invest in growing global franchises with cross-border brand appeal. Invest in companies with strong free cash flow – especially ones that pay decent and fair dividends. Avoid companies with high commodity input costs. Emerging market assets are OK for now but a bubble may be developing. Some inflation is a goal of the Fed – keep a real asset allocation except at exuberant extremes (TIPS, commodities, real estate, infrastructure, MLPs) Avoid long-duration fixed-income assets when inflation is a Fed goal. Push cash (zero-duration paper) into 2-year corporate paper – the Fed is on hold for at least 18 months. Avoid the detritus of the last bubble (domestic real estate and financials) for 5-10 years (tech stocks are finally rallying after crashing 10 years ago and look good). Stock markets will grind higher but we’re past the best part of the rally and … Multiples (P/E ratios) remain in a bear market. Sideways patterns last for 15 or 20 years. In this environment be tactical – not a buy-and-hold investor. Use valuation measures to avoid extreme bubbles but allow for some momentum. 41
100 Years of the Dow Highlights a Few Secular Bear Markets 42 Dow Jones Industrial Average (log scale) Source: Bloomberg, LP Secular bear markets last an average of 15 years.
Don’t “Buy and Hold” During Secular Bear Markets … 43 Offer Big Trading Ranges – Just Don’t Be a Buy-and-Hold Investor Source: Bloomberg, LP
Part 4: Conclusions
In Review The debt bubble had many causes and ultimately burst in late 2008. “Soggy” growth to continue in the U.S. on the back of an ongoing consumer deleveraging cycle. Across the globe, the bursting of the debt bubble has shifted risk from the private to the public sector. Bond investors have become vigilantes against the worst offenders and are picking off the Euro peripherals. But the peripherals are not in that much worse shape than the reserve countries. The emerging world is growing at a good clip but asset prices are getting frothy. Corporations are doing well and have tapped into pockets of growth around the world. Equities have rebounded from their lows but remain in a secular bear market. 45
Common Sense Advice for CEOs & Directors Try and tap into rapid growth in the emerging world (especially the BRICs). Establish overseas sales channels in the BRICs. Look for and try and sell to companies that have “cracked the code” and are doing well in the emerging markets. Some employees should be bilingual (Chinese, Spanish, Korean are important languages). Work on developing your brand. Everyone’s online now – improve your non-US-facing web presence if you’re looking to sell to the emerging markets. Geo-economic risks have made the currency markets quite volatile. Keep an eye on the foreign exchange markets. Commodities remain in a long-term bull market. If you manufacture, watch all of your commodity markets closely and consider hedging. Government customers will be much more frugal than in the past. Consumers will look for price points on the value side of the spectrum. 46
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